U.S. Dollar Regains Its Long-Lost Muscle, But the Cost Is High

Most of the news about the U.S. economy has been bad for the last two years, but not all: The good old American dollar has climbed back to a position of strength it hasn't enjoyed since the 1950s.

That strength has come at a very high cost. The dollar owes most of its resurgence to the same anti-inflation medicine, tight money and high interest rates, that has devastated the U.S. economy and pushed unemployment to the highest level since the Depression.

Moreover, the dollar's strength reinforces the effect of that medicine. Think about Toyotas, for example. A strong dollar makes imported cars cheaper and encourages Americans to buy more of them. The U.S. inflation rate is lower, but auto workers lose jobs.

Or take another example. The Rossignol Ski Co., the nation's largest ski manufacturer, announced earlier this month that it would end production at its Williston, Vt., plant partly because of the high value of the dollar. About 150 jobs will be lost.

Rossignol, a French-owned company, opened the Williston plant in 1974 when the French franc was worth about 25 cents. Recently, the franc has been worth only about 15 cents, and Rossignol can now make skis for the U.S. market more cheaply in France, where the workers are paid in francs but the skis still sell for dollars, the company said.

Comparative judgments of this sort undoubtedly helped produce the increase in imports in August reported yesterday by the Commerce Department, an increase that helped in turn to produce a record monthly merchandise trade deficit of $7.08 billion, more than $1 billion more than the previous high in February, 1980.

The dollar has climbed about 22 percent from its average 1980 value when compared to the currencies of the major countries with which the United States trades, with each currency weighted according to the volume of that trade.

The dollar's position on foreign exchange markets, on average, is just about the same as it was in June, 1970, when the Canadian government allowed its dollar to float, marking the beginning of the end of the fixed exchange rate system that major nations had used since World War II. That system was based on the dollar, whose value was set at $35 per ounce of gold.

Throughout much of the 1960s, the dollar had been under pressure as other nations had to build up unwanted hoards of the U.S. currency to preserve the $35 gold peg and protect the fixed exchange rate system. By 1973, when all major currencies were floated and the system died, the dollar's value had fallen sharply. As recently as 1980 international financial experts were proposing schemes to absorb some of those unwanted dollars in foreign hands in ways that would not disrupt the world's economy.

In each successive crisis on foreign exchange markets, the countries with the strong currencies--particularly West Germany and Japan--demanded that the United States take steps to raise interest rates to slow down economic activity and curb inflation, all of which would prop up the dollar.

What a difference two years can make.

More for domestic than for international reasons, the U.S. government finally followed that advice. The results have overwhelmed some of the governments that demanded the action.

As interest rates in the United States rose to record levels, investors seeking better returns switched their available funds out of other countries and invested them in this country. To do so, of course, meant they had to sell the German marks, or French francs or other currency and acquire dollars. The demand for dollars thus rose while demand for the other currencies fell, and the respective values on foreign exchange markets reflected the shift.

When the U.S. rate of inflation began to fall, some of the gap between inflation here and in other countries shrank, and that gave the dollar a boost.

Inflation rates are a major factor in how the relative values of countries' currencies will change. For example, the inflation rate in West Germany for years was substantially less than in the United States and the value of the dollar compared to the German mark fell steadily.

High interest rates had other impacts, too. The U.S. economy began to slow down in 1979, and when credit controls were applied in 1980, it fell into a deep but brief recession. Last year the Federal Reserve's anti-inflationary tight money policy again caused interest rates to increase and another recession followed. The slump in economic activity, which now goes back to 1979, reduced the U.S. demand for most foreign goods, including oil, and cut the U.S. trade deficit. The trade deficit in goods remained large, but other pluses in the nation's international accounts more than offset it.

With all the attention given the merchandise trade deficit, and the United States' especially large deficit with Japan, it is easy to overlook the fact that this country has had a substantial surplus for most of the last three years in its transactions with the world as a whole.

According to the Commerce Department, the U.S. merchandise trade deficit for the second quarter of this year was $5.8 billion. But when trade in services, flows of income from long-term investments and some other items, such as travel abroad and money sent home by foreign workers here, are counted, that deficit turns into a $2 billion surplus. This is called the balance on current account, and does not include the movement of long-term capital from one country to another.

The balance on current account is an approximate measure of whether the United States is adding to the dollars held in the rest of the world--a deficit--or reducing the amount of dollars held elsewhere--a surplus.

In 1977 and 1978, the United States had whopping current account deficits. By 1979 the deficit fell to less than $500 million, and the account has been in surplus every quarter since, except for the final three months of 1981. Some forecasts show the surplus reaching $7 billion this year.

Somewhere in the world, there are countries with matching current account deficits, and in those countries dollars will have to be borrowed, or dollar balances acquired earlier will have to be used to cover the deficits. That demand is helping keep the dollar's value high.

Another factor behind the dollar's unexpectedly strong performance is safety. As political and economic conditions sour in more and more countries, people with money are moving it to the United States where they think it will be more secure. So much money has moved out of financially hard-pressed Mexico, for instance, that the government has threatened action against its citizens if they do not bring home the cash they have sent here.

Even the recent decline in interest rates here has done little to dent the high-flying dollar's status. For one thing, other countries caught in the grip of recession, including West Germany, have taken advantage of the lower U.S. rates to knock their own rates down a notch. Earlier, these nations had been forced to raise their rates -- to the point of causing recessions -- to keep the value of their currencies from falling too far relative to the dollar.

High interest rates, continuing current account surpluses, the prospect of greater safety for investments and lower inflation rates are contributing to the dollar's strength. And that strength gradually takes its toll in reducing the demand for U.S.-made goods abroad.

Data Resources, Inc., an economic consulting firm, estimates that a 1 percent appreciation of the dollar on a trade-weighted basis increases the U.S. merchandise trade deficit by $1 billion after two years. Meanwhile, import prices are cut by 0.8 percent and export prices are forced down by 0.2 percent, as exporters accept a lower profit margin to try to keep their sales from falling.

The import price reductions cause Americans to buy more, raising real imports by 0.4 percent after two years. The export price increases, on the other hand, reduce real merchandise exports by 0.6 percent after two years, DRI concludes.

The dollar began its meteoric rise just about two years ago, but the other effects of the recession have dampened some of the impact implied by the DRI analysis. Once an economic recovery gets under way here, that impact should be much more visible, with imports rising more rapidly than exports.

With a sustained recovery, DRI predicts the merchandise trade deficit, expected to be about $23.5 billion this year, will double by 1984. The current account will swing from a $7 billion surplus this year to about a $6 billion deficit in 1984.

Most of that swing will be the result of the dollar's high value and the economic recovery. The swing, however, will be a drag on the recovery and will keep unemployment from falling as rapidly as it might. It means, in the simplest terms, that goods and services that might be produced in the United States for consumption here will be produced in other countries.